German, French officials scale back goals of upcoming European summit, will seek accord among 17 nations that use the euro, not with all 27 European Union members

Cindy Allen

BERLIN , December 7, 2011 (Associated Press) – German and French officials lowered expectations Wednesday for a deal to save the euro at this week's European summit, deflating investors' hopes for a broad resolution to Europe's debt crisis.

Instead of a new treaty among the 27 members of the European Union, a French official suggested a more likely outcome will be an accord by the 17 nations that use the euro. A German official said reaching a deal might take until Christmas.

The summit, which begins Thursday night, has been described as do-or-die for some eurozone countries, whose economies are being dragged down by crippling debts. Further urgency was added after the ratings agency Standard & Poor's threatened to downgrade European bonds. That would likely make it more expensive for governments to borrow.

German Chancellor Angela Merkel and French President Nicolas Sarkozy released the details Wednesday of a plan for eurozone nations to submit their economies to tighter scrutiny from a central European authority.

That proposal was cheered by markets because investors believe such an agreement would push the European Central Bank to take bolder action to reduce borrowing costs for Italy, Spain and other heavily indebted countries. That would give governments time to strengthen their finances.

After Thursday's comments by the German official, who like the French official spoke on condition of anonymity because the talks are ongoing, the markets turned lower. Germany's main stock index fell 1.1 percent, while in the U.S. the Dow Jones industrial average dropped 0.6 percent. The euro shed 0.3 percent to $1.3358.

"There is a very, very strong expectation that the summit is going to be a success so there is some potential for disappointment," said Stefan Schneider, chief international economist at Deutsche Bank. "But if there is a convincing plan, which — in contrast to some of the previous plans — might survive the next two or three weeks, then that could support markets in the first two or three months of next year."

In their letter to EU President Herman Van Rompuy, Merkel and Sarkozy stressed a decision was needed at this week's meeting to have the new treaty in place by March.

"We are convinced that we need to act without delay," they wrote.

Herman Van Rompuy, the president of the European Council, offered an alternative way to secure future fiscal discipline. He favors simply amending existing rules that apply to the 17 countries that use the euro. That would allow leaders to avoid the trickier step of requiring every country to approve the new treaty through parliamentary votes.

The German official dismissed the proposal as a "typical Brussels bag of tricks" that "lag behind both public and market expectations."

He insisted that to restore lost trust in the euro currency and calm markets, Europe needed the legitimacy of a properly agreed and ratified treaty.

"If several rounds of negotiations are necessary for that then we are also prepared for that," the official said, adding "there is still no majority on new treaty changes among the member states and institutions."

Indeed, he suggested the talks, scheduled to wrap up late Friday, might take longer to reach an agreement on the broad strokes of treaty changes.

"We have made no plans for the weekend," he said.

The senior French official said Paris expects to strike a deal with at least the eurozone's 17 members — and others who want to join voluntarily — by Friday night.

Certain provisions in the Franco-German proposal, such as setting automatic penalties for countries that overspend, are controversial and have the potential to delay an agreement.

The 10 EU countries that do not use the euro are concerned that they'll be left out of future economic discussions that would affect all of Europe. Germany has insisted that any interested countries would be welcome to adopt the changes of the eurozone 17.

British leader David Cameron is wary of losing influence within Europe if France and Germany create a tighter club of eurozone nations. His government also does not want to transfer any of its decision-making powers to Brussels.

Earlier Wednesday, U.S. Treasury Secretary Timothy Geithner struck a more optimistic tone on the prospects for a deal.

"We are very encouraged with the progress that is being made," Geithner said to reporters following a meeting with French Finance Minister Francois Baroin on the second day of his whirlwind trip through Europe.

A successful resolution of the differences between the European leaders is crucial if the ECB is to step up its support for weak eurozone countries.

ECB President Mario Draghi hinted last week that a commitment by euro countries to crack down on overspending could set the stage for further financial assistance from the bank.

Markets have interpreted Draghi's comments to mean that the ECB could get more aggressive in purchasing European government bonds. Those bond purchases would likely drive down interest rates, allowing debt-laden countries to cut their borrowing costs.

The ECB will hold a policy meeting on Thursday, and investors will watch Draghi's comments in a press conference for signs he considers Merkel and Sarkozy's proposal enough to embark on greater support for eurozone bond markets.

The proposals floated by the German and French leaders are based on several key issues:

- Having all 17 countries that use the euro amend their constitutions to require balanced budgets.

- Using EU institutions such as the European Commission to enforce penalties for countries that run excessive budget deficits. The use of those institutions might require that all 27 EU countries agree to it.

- Trying to increase the EU's financial ability to bail out countries.

- Pledging that any future bailouts would not require private bond investors to absorb part of the costs, as was the case for the Greek bailout.

- Finally, the proposal seeks to streamline the eurozone's future €500 billion ($669 billion) permanent bailout fund by suggesting that a majority of countries holding 85 percent of the ECB's capital should be sufficient to make all decisions. That would give the bloc's six biggest economies the power to outvote the remaining 11 nations, a move that is likely to be opposed by smaller countries.

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Gabriele Steinhauser and Don Melvin in Brussels, David McHugh in Frankfurt, and Greg Keller and Sylvie Corbet in Paris contributed to this report.

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